What Is the Impact of European Austerity Measures on Office Markets?

Historically high levels of national debt, combined with falling gross domestic product levels, have left some European economies exposed to sovereign debt concerns. For many countries, reducing national debt through austerity measures is the only option. As part of these austerity measures, job cuts are expected. Cutting public sector spending through job reduction will have a significant impact on the property sector in some markets.

The repercussions across Europe have been polarized. Property yields have remained high in peripheral economies, but have been driven down in core locations. Capital has shifted rapidly from countries most identified at risk, and even to less exposed cities within countries. However, the impact of occupier markets distress on rents is still playing out.

Those countries most exposed to austerity measures are Greece, Ireland, Italy, and Portugal. Some regions—such as eastern Germany, southern Italy, and northern Scandinavia—have high levels of exposure to public sector employment, highlighting their vulnerability. However, most countries remain largely unaffected by the crisis, insists global real estate adviser DTZ. The Nordic nations and countries within central and eastern Europe (CEE) remain best placed to weather the crisis as most have kept a tight grip on government finances. Not being part of the eurozone also allowed them to more effectively use monetary policy when dealing with the early stages of the crisis.

“Although there are some austerity measures in the public sector in Amsterdam, for example, I don’t know that those issues might worsen the problem, even though Amsterdam is understood to have a considerable amount of oversupply,” says Joe Montgomery, ULI Europe’s chief executive.

“In the U.K., quite a distinct and central part of the coalition government’s strategy for balancing the books is a major retreat from large-scale office space, certainly in the most expensive parts of its estate, which is in central London but more generally across the country, too. There is a big, relatively sophisticated program of smarter, ‘peripatetic’ working remotely from home and elsewhere, plus head count reduction and a reduction in per-capita space allocations, or number of desks per person, all of which are driving the public sector to require less space over time. That is being driven quite aggressively,” he adds.

Cuts in public administration employment will have a greater impact on office space demand in secondary locations than in major city centers, as second-tier regions and cities are generally the most exposed through high proportions of public sector employment. Some regions, particularly in the CEE and peripheral markets, are dominated by public administration, with up to 70 percent of the office workforce employed by the government. Generally, a high proportion of public administration in a workforce also correlates to a low level of financial and business services sector employment, so most major central business districts find themselves in a relatively strong position in terms of dealing with public sector job cuts.

Total returns in markets most affected by austerity measures connected to the evolving sovereign debt crisis are forecast by DTZ at 8.4 percent per annum 2011–2015. This is 25 percent higher than total returns in the least exposed markets (6.7 percent per annum). These returns are mostly driven by higher-income returns, as investors demand higher yields to invest in the most exposed markets.

Despite strong total returns, DTZ expects rental growth in the most exposed markets to be extremely subdued over the next five years. Austerity measures are dictating significant public sector job cuts in many markets, acting as a drag on rents by feeding through to overall economic growth. Overall, however, the impact of austerity measures on European office markets is currently limited to a handful of countries at the heart of the crisis, with the majority of key office markets only marginally exposed.

According to Trulia’s chief economist, U.S. home prices were 2 percent undervalued in the fourth quarter of 2014. But the most overvalued market in the country is now Austin, at 16 percent overvalue, followed by Orange County and Los Angeles in southern California. Nine of the 100 largest metro areas are 10 percent or more overvalued.

Competition for prime assets in Europe’s major real estate markets is leading investors to continue their move into secondary assets and recovering markets, according to Emerging Trends in Real Estate Europe 2015, a forecast published jointly by ULI and PwC.